This is called financial allocation where the cost and expenses within a company are distributed in such a way that values are correctly allocated between departments, projects, or products.
It is important in achieving a clear and accurate view of operating expenses and in helping to manage the finances of any business.
Costs and expenses can be divided into two main categories:
Direct Costs : These are costs directly related to production or operations. Examples include raw materials, direct labor, and specific inputs .
Indirect Costs : These are expenses that are not directly linked to a specific product or service, but that impact the overall operation of the company. Examples include rent, electricity, maintenance, and administrative expenses.
The goal is to distribute costs across departments, projects or products to ensure a clear and fair view of operational expenditures.
Why is Financial Allocation Important for Companies?
Cost Transparency :
Financial allocation offers a detailed view of how the financial resources are allocated to every sector, department, or project. This allows for easier comprehension of operational expenses, so managers know exactly where the money is being invested.
Resource Optimization :
By identifying waste and inefficiencies, financial allocation helps improve operational efficiency. This allows resources to be redistributed more intelligently, ensuring that priority areas or those with the highest return receive more attention.
Strategic Decision Making :
Accurate price statistics helps the managers make correct choices as far as distribution, investment, and cost-cutting are concerned. This, in turn, contributes to more strategic management that is aligned with enterprise goals.
Proper Pricing :
Correct cost allocation allows you to set fair and competitive prices for products and services. This ensures that prices cover total costs (direct and indirect) and provide a sustainable profit margin.
Budget Control :
Financial allocation is an essential tool for tracking and adjusting the finances on an ongoing foundation. This prevents financial surprises, allows for the forecasting of future prices and allows hold a stability between income and charges.
What is Cost Allocation for?
Cost allocation is a fundamental tool for companies’ financial control, allowing a detailed analysis of operational expenses from the acquisition of inputs to the completion of the logistics process.
It helps identify consumption patterns, align resources and improve financial management . Its main objectives include:
- Identify Excessive Spending : The apportionment allows you to locate areas where resources are wasted, enabling corrective actions to reduce unnecessary costs and improve efficiency .
- Support Investment Decisions : With accurate data on costs and expenses, the company can determine where to invest resources with the greatest potential return and where it is more prudent to make cuts.
- Measuring Profitability : Through proper cost allocation, it is possible to assess whether projects or products are bringing satisfactory financial returns. This analysis helps to adjust strategies and improve organizational performance .
- Assist in Pricing : Cost allocation provides fundamental information for establishing prices that cover all operational costs and provide an adequate profit margin, ensuring competitiveness in the market.
Types of Allocation in Corporate Financial Management
1. Absorption Allocation
Also called full costing , this method allocates all production costs, including direct and indirect, fixed and variable costs.
It is widely used to assess the profitability of products and services.
Example : If a factory has production costs of R$100,000.00 and indirect costs of R$20,000.00, absorption apportionment will distribute the R$20,000.00 among all products manufactured.
2. Activity-Based Costing (ABC)
Activity-Based Costing , also known as ABC (Activity-Based Costing) , is a method that allocates costs based on the specific activities performed in each sector or project .
This model is especially useful for companies with complex operational processes or that perform multiple activities with different levels of resource use. The goal is to better understand costs and identify which activities generate the greatest financial impact.
Practical example: In an industry that has several production lines, the cost of machine maintenance can be shared proportionally based on the time of use of each production line . Thus, each production line contributes a fair share of the costs, according to its participation in the company’s activities.
3. Distribution by Headcount
Headcount Allocation distributes costs based on the number of employees (headcount) allocated to each department or sector of the company.
It is a method widely used in service and consulting companies, where administrative and operational costs are generally linked to the number of employees in each area.
Practical example: Suppose the total administrative costs are R$ 10,000.00, and we have two departments with different numbers of employees:
- Sales Department: 10 employees
- Marketing Department: 5 employees
The distribution will be proportional to the number of employees, that is:
- The Sales Department represents 10/15 of the total number of employees → R$ 6,666.67 (10 x 10,000 ÷ 15)
- The Marketing Department represents 5/15 of the total employees → R$ 3,333.33 (5 x 10,000 ÷ 15)
This method ensures that costs are distributed proportionally to the amount of human resources allocated to each sector, allowing greater precision in financial control.
4. Allocation by Revenue
Allocates fees primarily based at the sales generated by means of every service or product.
Example : If a company has a total cost of R$50,000.00 and two products, one that generated R$30,000.00 and the other R$20,000.00, the costs will be allocated proportionally to the revenue.
5. Allocation by Direct Costs
Direct Cost Allocation is an approach that allocates expenses directly related to the production process, identifying and associating specific costs with each product or unit produced.
These costs include raw materials , direct labor , and other resources essential for production. This method is ideal for companies looking to identify the direct relationship between their costs and the units produced.
Practical example:
In a furniture factory , the cost of the wood used for production and the labor of the workers can be allocated directly to each piece produced.
6. Allocation of Indirect Costs
Indirect cost allocation involves distributing costs that are not specific to a product or service.
In general, the indirect cost of a firm covers many common company-wide expenses. They include rents, electricity, maintenance, insurance, and general services.
These indirect costs should be distributed evenly among sectors of a company in an organizational setup for everyone to make proportionate contributions to the business.
Practical example: If the factory rent is R$12,000.00, it cannot be exclusively attributed to one product or sector. Therefore, it can be shared proportionally among different departments, such as:
- Production Department (responsible for manufacturing products),
- Logistics Department (involved in distribution),
- Administrative Department (responsible for management and internal operations).
The apportionment can be calculated based on the area occupied by each department, ensuring that each one pays a fair share of the expense.
7. Standard Costing
This method serves as an indicator of production efficiency. There are four subdivisions:
- Standard Cost : Target defined for inputs and production .
- Optimal Cost : Long-term goal with maximum efficiency .
- Estimated Cost : Based on past projections .
- Current Cost : Short and medium term target, suitable for control.